Monday, October 9, 2017

Inside the Index

If you write about personal finance long enough, you find yourself walking some well-worn ground. After a while, it seems we all take a crack at the same tired problems that so many other writers have over the years.We've all written about paying off consumer debt. And who hasn't had a hot take on a way to be just a little more frugal?So with my apologies, today I'm writing about a subject that you've all heard about too much these days: genocide, and why it's not good.Vanguard sent us some mail the other day: a fat envelope with a proxy vote inside. Vote for this old geezer or that one to be on the board to, I don't know, maybe run a mutual fund or something. But then buried in the middle of the thing was Proposal Seven:

"Proposal 7—

Also, shareholders of certain funds will be asked to consider a proposal
submitted by one or more shareholders to: Institute transparent procedures to avoid holding investments in companies
that, in management’s judgement, substantially contribute to genocide or
crimes against humanity, the most egregious violations of human rights.
Such procedures may include time-limited engagement with problem
companies if management believes that their behavior can be changed."

The example cited in the proposal, which apparently came from a shareholder, is Vanguard's $835M investment in PetroChina, which just happens to be Sudan's largest business partner. As a result, investors in various index funds may be unwittingly funding genocide in the Darfur region of Sudan. And the issue of Vanguard and genocide has actually come up before.Here's how the proposal lays out its argument:

f) Other large financial firms such as T. Rowe Price and TIAA-CREF
have avoided investments connected to genocide by divesting problem
companies such as PetroChina."

Seems reasonable enough, right? But there's a counter-argument, and it just happens to be coming from Vanguard's board.Vanguard is openly recommending its individual investors to vote against this proposal, for a handful of reasons. Vanguard's stated reasons are in quotes, with my thoughts posted immediately after in italics.1) "Meaningful long-term solutions to these
issues require diplomatic and political resources to come together to implement
change."While this is undoubtedly true, this doesn't necessarily lead to the idea that individual investors should wipe their hands of any responsibility of funding genocide, the deliberate killing of a group of people, while politicians and diplomats work their influence. Along the same lines, diplomatic and political solutions are going to be necessary for disarming North Korea, too. But that could take decades. I don't want my FIRE dollars funding Kim Jong Un's regime in the meantime.

2) "Vanguard is fully compliant with all applicable U.S. laws and regulations"So while genocide is very bad, investing in companies that contribute to genocide is not technically against the law. Well whooptie-fucking-do, we've cleared the bar of legal culpability.

3) "The addition of further investment constraints is not in Fund
shareholders’ best interests."Basically, this might not be as profitable. This seems like the 'real' reason that a board of trustees would make such a recommendation.

4) "Divestment is an ineffective means to implement social change."Since Vanguard is selling the shares on the secondary market (i.e. - not back to the company itself, but just to another investor), this isn't a particularly effective approach. It doesn't hit the company where it hurts.

So there are both sides of the coin. You don't have to work too hard to figure out what side I'm on.Why the fuck is this even a question?This issue is being debated all over the personalfinancespace. Many of the opinions follow a laissez-faire approach. The point is to own the index, the whole index, and not to interject morality or politics into the passive investing approach. If that's your aim, go buy a socially-responsible index, right?But must we take an amoral view in order to be index investors?Is there literally no line that can be drawn with passive investing? If a company abroad engages in, or helps fund, warlords, genocide, slavery, child prostitution or any number of other things that might be profitable-but-reprehensible and, that, within our own country would certainly be illegal, must such a company be included in an index fund simply because it fits within the boundaries of the index?From where I sit, it seems logical that a company could be excluded from an index if it is funding genocide. It's such an obviously immoral, and clearly illegal, activity, that it hurts my fucking brain to think of why we even need to have the discussion.But let's play devil's advocate. As any number of faithful index-fund believers have noted, passive investors buy the whole index precisely because they do not want some guy, or some board of guys, to be picking specific companies to exclude from the mutual fund. That's the whole idea of index funds. You buy the whole thing. Not the whole-thing-except-these-handful of companies-we-find-disgraceful.And that's fair. Index investing is supposed to take human decision making out of the equation. Such a proposal would change that, almost unavoidably.But I don't really care about the performance of the index I'm investing in, or whether the type of investing I'm doing technically counts as truly passive, if something as obvious as "management deciding if a company is contributing to genocide" is off the table. That's probably enough time on the soapbox for a Monday morning. Perhaps I'm missing something critical about the issue. Maybe you can let me know about it in the comments below.
And remember that decisions on things like tacitly supporting genocide can be buried deep in the tiny print of junk mail.As always, thanks for reading.*Photo is from wagdi.co.uk at Flickr Creative Commons.

I definitely think SRI Index funds might be where it's at for people who care about this stuff.

But, separately, I think that "regular" index funds ought to exclude (or at least have the ability to exclude) companies that blatantly break laws that are universally accepted like, you know, not systematically killing a whole group of people.

That is to say, we ought not need to invest in a special "socially responsible" fund in order to avoid funding genocide. That should be the default option on all mutual funds.

My favorite is the "where do we draw the line" rebuttal. Uh, around mass murder. That is exactly where lines go.

I said this in my article's comments, but I will reiterate: money cannot solve all problems, but a lack of money is the fastest way to create problems. And I would VERY MUCH like to use my money to create problems for these fuckers.

And even if such an approach isn't necessarily the most effective (when compared to the actions of governments or militaries), that does NOT lead us to just throwing up our hands and sending our billions of dollars anywhere that is profitable. There's a justification to simply saying that we don't give our money to companies that support genocide, or slavery, etc.

That shit may happen regardless, but it shouldn't happen with our money.

I had the exact same reaction when I saw that question in the voting menu, and read it to my husband like it was some kind of joke. I immediately clicked in support of it, though I wish I had done the analysis you did. Now I feel good about my vote. Win. Much appreciated!

Thanks for posting this. I was just going to ignore the vote but voted against it now that you raised this issue. I did skim through a few comments on other forums about it being a "slippery slope" and where do we draw the line, etc, etc...and some comparing it to investing in tobacco companies (which is not an apt comparison!). While they make some reasonable points to an extent...I feel very comfortable in voting to get rid of companies that help fund genocide.

Although I agree with the proposal and your view in spirit, I think the active vs. passive and slippery slope arguments are valid and shouldn't be dismissed so easily. Also, the legal obligation and ensuing liability to vanguard to now be responsible for making this determination (or possibly making a wrong determination) is fairly significant.

The Petrochina/Sudan genocide issue has been contested for about a decade or so and while intutition and even logic make us believe that it contributes to genocide (more indirectly than directly) it becomes a problem in affirming the following: "substantially contribute to genocide or crimes against humanity." Is Petrochina actually doing this, are there facts and proof that it is willfully contributing to this....I don't know. Also, the SEC can punish the company through sanctions on the company itself including delisting and prohibiting any US Business from doing business with it - why not write your senator. Never happen because Petrochina and its parent is significant to China overall so US gov likely won't poke that monster.

Brings me to another issue...if its deemed that Petrochina contributes to genocide and Petrochina is stateowned then by default all companies/investments that are state owned and/or controlled should also be included, should they not? Won't leave much left to invest in China. Its not as easy as it seems.

I certainly don't think it would be easy, but it's important to understand what the proposal actually outlines. It only proposes transparent procedures be put in place, and that they be put in place by the Vanguard board. That gives a TON of latitude to Vanguard to develop the methodology.

That is to say, the slippery slope argument isn't particularly strong because the board, which advocates against the proposal, would be in charge of deciding the methodology, how sweeping it is, and how rigidly it is applied.

More convincing is the fact that Vanguard would not be blazing a trail here: there's already precedent set by T Rowe Price and TIAA CREF, which have not see the sort of slippery slope consequences that are argued about on various message boards.

I've thought a lot about this. I think I'm coming around to your point that we really can draw lines in the sand. I mean, I *know* what the US is doing in Yemen, and that makes me creeped out buying US government bonds, but that pales in comparison to Darfur. Sudan may be where the worst human rights abuses are happening anywhere on earth right now.

The thing that still gives me pause is how interconnected the global economy is. Does selling stock from PetroChina hit Sudan in the pocketbook better than eliminating gum arabic from my diet? I have no idea. A great many things help fund genocide.

I think you're right, Becca. The web of where our money goes is damn hard to track down and we end up funding a lot of things we would find abhorrent, if we even knew about them.

A phrase I like from the twelve steppers is "Progress, not perfection". I personally think that such a proposal would make some progress re: our funds being kept from evil uses, albeit leaving us a hell of a long way from perfection.

I wouldn't have thought much of the letter that I got in the mail -- nine times out of ten, I'd have just thrown it away or just voted in favor of the board's recommendation without reading the whole booklet.

But yeah, if you can't draw the line for funding genocide, we're stating that with our investment dollars, there is no line.

This is probably a dumb question, but how does buying stock support a company? Obviously, when they first sell stock, you are buying it from the company and thus giving them your money. But after that, aren't we just giving it to random other stockholders whom we know nothing about?

(The concept of we stockholders profiting off of evil is also relevant but that's a whole other issue.)

You're correct, Debbie, and this is the final point the Vanguard board makes. When you sell an investment, you are simply selling to another investor in the secondary market, not back to the company.

That said, if some big investor (or lots of big investors) sell all their positions of a stock on the secondary market, there's an impact on price. The board of that Petro company would notice.

Additionally, there's a lot of influence this proposal could have outside of merely selling the stock: that is, using their stakeholder influence to impact the policies of such a company during investor calls.

Okay, thank you. I've heard of stakeholder influence making a difference, so that sounds awesome. But it sounds like Vanguard doesn't want to do that and like it could increase their costs and thus their fees.

Yeah totally. I wonder why people think index investing abdicates them of any and all moral responsibility. That's resoundingly infantile. How many dead bodies is it OK to stack up on the way to retirement?

Before I get too self righteous, I've had my own dilemmas deciding whether to invest in certain stocks (e.g. gambling/tobacco/weapons manufacturing) but whilst these things are far from illegal there is less of a clear cut choice around them. But for fucks sake, genocide.

I don't know if someone already mentioned this since I haven't read all comments, but I am annoyed by the comeback - "just go buy a social responsibility fund" - because what if I am not bothered by everything a social responsibility fund avoids but am clearly bothered by genocide and don't want my money used to fund it? That's where I stand, and I voted "yes" on Vanguard Proposal 7 - Genocide Free Investing, contrary to Vanguard management urging a "no" vote. And now I'm conflicted that to get out of Vanguard's funds, I'll have a very substantial amount of capital gains tax to pay. The proposal was if "in management's judgement" a company "substantially contributes to genocide", the company should be divested - what is unreasonable about that, since it leaves it to the Vanguard board's discretion?

Disclaimer: This blog is written for entertainment purposes only: not to give advice. I'm just some dude on the internet, and one without a whole lot of credentials. It's a good idea to consult with professional before making investment, tax, or financial decisions.